Why suing critics usually backfires

HerbGreenberg

This column originally appeared in the weekend edition of The Wall Street Journal.

SAN DIEGO (MarketWatch) -- You would think that by now public companies that monkey with their numbers would get the hint: Suing critics almost always backfires.

If nothing else, lawsuits or other attempts to discredit short-sellers, bearish analysts and others -- including financial journalists -- are often, in an oddly backhanded way, confirmation that the critics will be proved right.

The latest company to learn that lesson the expensive and embarrassing way -- and perhaps the most stunning example of why companies shouldn't attack their critics unless they absolutely, positively have reason to do so -- is Biovail
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a Canadian drug company.

Two years ago, it sued a handful of critics, including Gradient Analytics, an independent research firm, on racketeering charges for engaging in what it called "a massive, illegal and continuing stock market manipulation scheme."

Central to the allegations, according to the lawsuit, "was and remains short selling."

Short-sellers, of course, bet that stocks will fall. As a result, they often are automatically portrayed as the bad guys. That is why Biovail's lawsuit made a splash, and why its claims went on to become the centerpiece of a report on the CBS show, "60 Minutes," about how hedge funds allegedly colluded with analysts to drive down its stock price.

It didn't matter, apparently, that at the time Biovail was under investigation by the Securities and Exchange Commission.

As a result of the publicity surrounding Biovail's claims, the SEC launched a probe of Gradient, which was eventually dropped, leading to the ultimate of ironic twists: In recent days, Biovail was sued by the SEC on charges of accounting fraud based, in part, on the same charges levied by Gradient and David Maris, who had been an analyst at Bank of America Corp.
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Maris was originally named in the suit, but his name was later dropped.

After being sued by the SEC, Biovail quickly settled without admitting wrongdoing, by paying $10 million. The company, which hasn't withdrawn its lawsuit, has declined further comment.

The Biovail flap is reminiscent of the time AremiSoft, a software company, sued a bunch of hedge funds and my employer at the time, TheStreet.com, for market manipulation and disseminating false information. The suit was dropped after the SEC, in one of those odd turns, sued AremiSoft for the very things I had reported. AremiSoft filed for bankruptcy reorganization, and the firm no longer exists.

As for Biovail, Gradient and Maris, who now works for a hedge fund, say they feel vindicated. Gradient President Brad Forst adds, however, that "there's something wrong with this when we have to spend years and millions of dollars (defending lawsuits) to do our job."

Indeed there is, but as long as there are people betting that stocks will fall, and others reporting on what they are saying, there will be companies that think they can make themselves look more credible, while diverting attention away from the bad stuff, with a lawsuit. Sadly, especially for shareholders who foot the bill, that is just the way it is.

All this is worth remembering in the wake of the collapse of Bear Stearns Companies. Inc.
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Accusations flew across Wall Street accusing hedge funds of shorting Bear stock and then conspiring to drive it down by pulling their accounts. This may ultimately turn out to be true, but it doesn't disguise the fact that Bear was the riskiest player in a risky industry during a very risky time. Successful short-sellers figured this out before everyone else.

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Short sellers -- and the SEC: One other thing companies may want to consider, before filing suit, is that the SEC doesn't turn away tips from anybody. "It's not unusual for short-sellers to come to us with allegations of misstatements by companies," says Andrew Calamari, associate director of the New York office of the SEC, which oversaw the Biovail suit. "We get many types of referrals every year, and we do evaluate them because short sellers have to be taken at face value. They're not, as a matter of logic, just shorting a stock to bring it down, but they're shorting because they think it's a bad company. Sometimes they're right; sometimes they're wrong." Always early.

How to stop analyst intimidation: Maris, who left Bank of America shortly after the Biovail flap, believes the government should do more to help analysts blow the whistle on intimidation of their work. He suggests that the SEC create a hotline for analysts to call "without fear of retribution from anyone if they are suspicious of wrongdoing at a company or if they feel intimidated in any way." Great idea.

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